Bank of England (BoE) sent a hawkish signal to markets, as it might tighten monetary policy 'over coming months' if underlying inflation moves higher and the unemployment rate moves lower.
The tightening bias challenges the view that BoE will stay on hold through Brexit negotiations due to high political uncertainty and slower growth. The policymakers have become more concerned about the combination of unemployment below NAIRU and inflation above 2%.
We now think a BoE hike in November is a close call but given that one condition is 'a gradual rise in underlying inflationary pressure', which we interpret as higher wage growth, we still think BoE will stay on hold this year.
Our base case is now a hike in Q1 18, as BoE is less worried about political uncertainty and more focused on economic data. Markets pricing seems fair, as a November BoE hike is priced in by approximately 60% and a full hike is priced in by February.
Risks in EUR/GBP are now more balanced than what we had laid out (previously saw risks tilted to the upside for the cross near term).
That said, our preposition remains that EUR/GBP will have a hard time breaking significantly lower from here as Brexit uncertainty is set to be a subjugate for the GBP for an extended period of time. Near term, the cross should be capped around the 0.88 level (which prevailed before the summer uptick).
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